MONETARY POLICY OF INDIA. And how RBI controls Inflation

Transcription

1 MONETARY POLICY OF INDIA And how RBI controls Inflation

2 WHAT IS MONETARY POLICY? Monetary policy is the process by which the monetary authority of a country, like the central bank or currency board, controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency. The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy.

3 OBJECTIVES OF THE MONETARY POLICY OF INDIA Growth with stability Regulation, Supervision & Development of Financial Stability Promoting priority sector Generation of Employment External Stability Encouraging Savings and Investments Regulation of Non Banking Financial Institutions

4 MONETARY POLICY IMPLICATIONS DECISIONS

5 TOOLS OF MONETARY POLICY Tools of Monetary Policy Quantitative Measures Qualitative Measures Open Market Operations (OMO) Bank Rate Variations in Reserve Ratios Credit Rationing Change in Lending Margin Moral Suasion Direct Control

6 6 WHY RBI NEEDS TO CONTROL THE MONETARY POLICY?

7 WHY RBI NEEDS TO CONTROL MONETARY POLICY? Initially people used Barter System for trading. But the barter system had many problems. Therefore, people switched to money system. So, Financial Intermediates came into the picture. Financial Intermediaries = Middlemen who help in the circular flow of money between households and business firms. There are two types of financial intermediaries: banking institution and non-banking financial institutions. RBI controls (all) banks and (some) non-banking financial institutions. RBI s main job is to control Money supply in this game, and thereby fight inflation and deflation.

8 WHY RBI NEEDS TO CONTROL MONETARY POLICY? Inflation = price rise = bad for economy, you know that by common sense. But Deflation = price decrease = we can buy things at a lower price. Isn t that good? Why is deflation bad for economy? Every business has fixed cost of production say minimum light bill, phone bill, office rent, staff salary etc. So, if prices keep falling and falling (say of Nano car), then car marker will suffer losses. He has no motivation to expand business. He wants to cut down his production costs, by firing some of the employees= less new jobs created= unemployment = social unrest. If prices of everything fall- then custom duty, VAT, excise duty, service tax- their collection will also decrease. Then government has less money to spend on education, healthcare, social sector, defense, law and order = poverty, disease, crime.

9 SO, WHAT IS MONETARY POLICY? Policy made by the central bank. To control money supply in the economy. (and thereby fight both inflation and deflation). RBI implements monetary policy using certain tools. Two types: Quantitative tool Qualitative tools Let s understand what that means

10 QUANTITATIVE MEASURES OF MONETARY POLICY

11 OPEN MARKET OPERATIONS Open Market Operations or OMO refers to the purchase and/or sale of short term and long term securities by the RBI in the open market. OMO is used to wipe out shortage/excess of Money in Money Market, to influence the term and structure of interest rate and to stabilize the market for government securities. OPEN MARKET OPERATIONS

12 OPEN MARKET OPERATIONS When RBI sells securities in open market, commercial banks and public buy it. This reduces the existing money supply as money gets transferred from the Commercial Banks to RBI. RBI Individuals Sells Securities Thus EXCESS MONEY SUPPLY reduces Controls Inflation

13 OPEN MARKET OPERATIONS When RBI buys securities from commercial banks in open market, commercial banks sell it and get back the money they had invested in them, thereby increasing the existing money supply. Buys Securities RBI Individuals Thus SHORTAGE of MONEY SUPPLY is eased Controls Recession

14 BANK RATE Bank Rate or Discount Rate is the MINIMUM rate at which RBI provides loans to the Commercial Banks Funds are provided either through lending directly or discounting or buying money market instruments like commercial bills and treasury bills. Pays Interest RBI Gives Loan

15 BANK RATE Bank Rate Increases = Cost of Borrowing of Commercial Banks Rises = Fall in Credit Volume to Banks = Reduction in Money Supply Current Bank Rate of RBI is 6.75% Pays Interest RBI Takes Loan

16 TEST YOUR KNOWLEDGE!! Answer the following question: Which of the following ratios are decided by RBI? a) Cash Reserve Ratio b) Statutory Liquidity Ratio c) Repo and Reverse Repo Rate d) All of the above Let s discuss each one of them in detail: